Quote of the Day - Whiteside's law of Real Terms

When an inflation adjustment is made to describe the impact of a change in people's circumstances "In real terms" the impact will always be perceived as follows.

If a change is supposed to be bad news "in real terms" such as a rise in the cost of living, it will seem all too real.

If a change is supposed to be good news "in real terms" such as an increase in real income, the improvement will appear to be wholly imaginary.


Jim said…
"Real terms" is a rather confused figure of speech to start with. There is nothing less "real" than a figure which has been adjusted for the price level. This is due to the nature of price raises caused by inflation. Inflation is often quoted as "a rise in the price level" this is not the case inflation is An increase (real or perceived) in the money supply relative to the supply of goods and services"

The price level is of course another ill defined idea. Lets say I fill a level bottom swimming pool with a garden hose (I have a lot of time, and lucky me I have no water meter) anyway as I increase the amount of water the water level seems to very slowly raise in a uniform fashion at every point of the swimming pool. we don't get 6 feet of water at the fill end and 2 feet at the other, the level of the pool raises slowly and uniformly throughout the entire pool. Where ever you are in the pool you could say the rate of the water level increase is 1" per day.

Prices do not do this, see in this case the hose is replaced by the "new money supply" rather than go into FRB and things lets just assume all of it comes from the BoE.
So the BoE "turns on the printing press (the tap)" and the new money arrives. No prices have yet risen, so the BoE is "quids in", The new money is used to buy government bonds, no prices have yet increased so the government is a winner. The government decide to spend the new money on a new railway line. They buy steel and wood, following the purchase steel and wood suppliers raise prices in response to the increased demand. The iron ore miners raise their prices due to the increased demand and new money, The iron ore tool extraction company's raise their prices next due to the new demand and new money etc etc etc and so we carry on as the "new money" circulates around the economy.

What we see is the early recipients benefit from the new money, as the prices have not risen yet, but they have new money. Of course as the "new money circulates more and more things become subject to the price increase.

So who loses? Well, those who are the last receivers of the new money lose most of all, see all the prices have risen before they see the "benefit" of the new money, they only had the old amount of money and noticed different goods increasing in price one by one. The later receivers of the new money are almost always those on a salary or benefit which is adjusted annually, in line with "inflation"

Usually they see the new money the same day as the government raises its taz levels in line with "inflation" so in fact those people never even "catch up"


The price level is never a flat raise, inflation benefits the early receivers at the cost of the later ones. Governments are always one of the first receivers, inflation is nothing but another tax, real terms therefore is simply a way of saying "after governments have taken a certain amount of your spending power" As there is no flat price increase, then the "level of price rises" is nothing more than a best guess, and it depends on the current spending priorities of the entire economy at any given time.

Inflation is one of the most evil stealth taxes ever. Henry VIII was legionary at it, he used a slightly different method (debasement) but its pretty much the same thing, it made him a fortune and funded his wars. Love of inflation is the primary reason politicians love fiat currency, it helps hide from view that which is taking place.
Jim said…
You may once again miss the point, the point is that no person or no party may ever be trusted with our money.
It's that simple, power corrupts, and it is that simple thing that must be removed from the status quo

I say again:

1. the people are sovereign:
The sovereignty of the peoples of England, Wales, Scotland and Northern Ireland shall be recognised by the Crown and the government of our nations. The people in their collective form, by giving their consent, comprise the ultimate authority of their nations and the source of all political power;

2. local democracy:
The foundation of our democracy shall be the counties (or other local units as may be defined), which shall become constitutional bodies exercising under the control of their peoples all powers of legislation, taxation and administration not specifically granted by the people to the national government;

3. elected prime ministers:
To enable separation of power, prime ministers shall be elected by popular vote; they shall appoint their own ministers, with the approval of parliament, to assist in the exercise of such powers as may be granted to them by the sovereign people of England, Wales, Scotland and Northern Ireland; no prime ministers or their ministers shall be members of parliament or any legislative assembly;

4. all legislation subject to consent:
No legislation or treaty shall take effect without the direct consent of the majority of the people, by positive vote if so demanded, and that no legislation or treaty shall continue to have effect when that consent is withdrawn by the majority of the people;

5. no taxes or spending without consent:
No tax, charge or levy shall be imposed, nor any public spending authorised, nor any sum borrowed by any national or local government except with the express permission of the majority of the people, renewed annually on presentation of a properly authenticated budget which shall first have been approved by their respective legislatures;

6. a constitutional convention:
Parliament, once members of the executive are excluded, convenes a constitutional convention to draw up a definitive codified constitution for the people of England, Wales, Scotland and Northern Ireland, which shall recognise their sovereign status and their inherent, inalienable rights and which shall be subject to their approval.
Chris Whiteside said…
O.K. there is a lot there.

First and perhaps most importantly I entirely agree with you about the corrosive, damaging and to some extent corrupting effects of inflation.

As you know, Jim, I'm an economist by profession, and we have to measure changes in the price level, however arbitrary and imperfect all such measures are, because ignoring the fact that the general level of prices does change when there is inflation or (much more rarely) deflation in the system can create even worse distortions than making an effort to correct for them does.

The expression "in real terms" as contrasted to "in money terms" is understood by economists and accountants to mean that there has been an adjustment to allow for inflation in line with the movement of a recognised price index.

Keynes referred to the problems which will be experienced by anyone who assumes that the value of money is fixed as "money illusion" and those problems will apply whatever definition of inflation you use.

If there is inflation in the economy, whether you define it in terms of rising prices or a change in the money supply relative to the supply of goods and services, then a person who has fixed income expressed in cash terms will see a drop in the purchasing power of that fixed income, and that drop in "real income" will both be, and be perceived to be, all too real.

Similarly if you have an increase in your cash income of about five percent, but inflation, whether expressed in terms of money supply or a basket of price changes as economists usually do measure it, is running at ten to fifteen percent, then the range of things you can buy with your income will be diminished. Unless your pattern of spending is skewed towards goods whose price is not behaving in line with average prices (very unusual but it can happen) you will perceive a drop in your "real" income which will seem all too real. And will be all too real.

My reason for believing that negative impacts on your standard of living "in real terms" will seem all too real while positive ones will appear wholly imaginary is that

1) such calculations will in practice occasionally be wrong or misleading, and this is more likely to be noticed if it moves in the wrong direction

2) As Northcote Parkinson predicted 50 years ago, we tend to see "expenditure rises to meet income" and we rapidly find things to do with any extra money we have. But any adverse movement such as a rise in the price of something we need is very noticeable. And the bigger the rise, the more noticeable.

3) So in a time of inflation, even if our real income has genuinely increased, we are likely to notice the worst rises in prices most, and they will colour our perception of what is happening to prices in general.

If prices are going up faster than our income, we will almost certainly realise this, and accurately realise that our real income has fallen. If average prices are going up by slightly less than our income but some prices significant to us are going up by a lot more, it is likely that we will percieve the latter as an indication of the true level of inflation and believe that the purchasing power of our income has actually fallen.
Chris Whiteside said…
Don't know why the system is showing your second post, e.g. your response to my initial reply above the post it is a reply to, but never mind.

My original post was about the impact of inflation, and specifically about the fact that the uncertainty generated by inflation destroys confidence because it will make people feel worse off, especially if they actually are, but quite possibly even if they are not.

There's a lot of interesting thoughts in your second posts about the need for a more limited and constrained government.

I am a supporter of more limited government so I am instinctively sympathetic to a lot of what you write. I will have a think about some of the points you make and come back. Perhaps set up a new thread to discuss.
Jim said…
"I will have a think about some of the points you make and come back. Perhaps set up a new thread to discuss."

Yeah, sounds good (always like debating ideas) would suggest to go point by point, thus allowing maximum discussion of all 6 points and allowing anyone to add their comments.

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